Prepaid expenses

Definition

Prepaid expenses are payments made in advance for goods or services to be received in the future. These payments are recorded as assets on the balance sheet until the benefit is realized, at which point they are expensed.

5 Must Know Facts For Your Next Test

1. Prepaid expenses initially appear on the balance sheet as an asset.
2. As the prepaid good or service is consumed, a corresponding expense is recognized on the income statement.
3. Common examples include rent, insurance premiums, and subscriptions.
4. The adjusting entry for prepaid expenses involves debiting an expense account and crediting an asset account.
5. Failing to adjust prepaid expenses can result in overstated assets and understated expenses.

Review Questions

• Where are prepaid expenses recorded initially in financial statements?
• What happens to prepaid expenses as they are consumed?
• Give two examples of common prepaid expenses.

Related terms

Accrued Expenses:

Obligations for which payment has not yet been made but is due for goods or services already received.

Deferred Revenue:

Money received by a company for goods or services yet to be delivered; recorded as a liability until earned.

Adjusting Entries:

Journal entries made at the end of an accounting period to update account balances before financial statements are prepared.